managerial accounting and Cost concept

1. Managerial Accounting and
Cost Concepts
CHAPTER 1
Managerial Accounting
Seventeenth edition

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Needs of Management
Financial accounting is concerned with
reporting financial information to external
parties, such as stockholders, creditors, and
regulators.
Managerial accounting is concerned with
providing information to managers within an
organization so that they can formulate plans,
control operations, and make decisions.

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Purposes of Cost Classification
1. Assigning costs to cost objects.
2. Accounting for costs in manufacturing
companies.
3. Preparing financial statements.
4. Predicting cost behavior in response to changes
in activity.
5. Making decisions.

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Learning Objective 1
Understand cost classifications used for
assigning costs to cost objects: direct costs
and indirect costs.

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Assigning Costs to Cost Objects
Direct costs
• Costs that can be easily
and conveniently traced
to a unit of product or
other cost object.
• Examples: Direct
materials and direct labor
Indirect costs
• Costs that cannot be easily
and conveniently traced to a
unit of product or other cost
object.
• Example: Manufacturing
overhead
Common costs
• Indirect costs incurred to support a number of cost objects.
These costs cannot be traced to any individual cost object.

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Learning Objective 2
Identify and give examples of each of the
three basic manufacturing cost categories.

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Classifications of Manufacturing Costs
Direct
Materials
Direct
Labor
Manufacturing
Overhead

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Direct Materials
Direct materials are raw materials that become an
integral part of the product and that can be
conveniently traced directly to it.
Example: A radio installed in an automobile

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Direct Labor
Direct labor costs are those labor costs that can be
easily traced to individual units of product.
Example: Wages paid to automobile assembly
workers

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Manufacturing Overhead
Manufacturing overhead includes all manufacturing costs
except direct material and direct labor. These costs cannot
be readily traced to finished products.
Includes indirect materials
that cannot be easily or
conveniently traced to
specific units of product.
Includes indirect labor costs
that cannot be easily or
conveniently traced to
specific units of product.

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Manufacturing Overhead – Examples
Examples of manufacturing overhead:
• Depreciation of manufacturing equipment
• Utility costs
• Property taxes
• Insurance premiums incurred to operate a
manufacturing facility
Only those indirect costs associated with operating the
factory are included in manufacturing overhead.

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Prime Costs and Conversion Costs
Manufacturing costs are often classified as
follows:

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Nonmanufacturing Costs
Selling Costs
Costs necessary to
secure the order and
deliver the product.
Selling costs can be
either direct or indirect
costs.
Administrative
Costs
All executive,
organizational, and clerical
costs. Administrative costs
can be either direct or
indirect costs.

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Learning Objective 3
Understand cost classifications used to
prepare financial statements: product costs
and period costs.

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Product Costs
Product costs includes all the costs that are
involved in acquiring or making a product.
Product costs “attach” to a unit of product as it is
purchased or manufactured, and they stay
attached to each unit of product as long as it
remains in inventory awaiting sale.

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Manufacturing Product Costs
For manufacturing companies, product costs
include:
• Raw materials: Includes any materials that go into the
final product.
• Work in process: Consists of units of product that are
only partially complete and will require further work
before they are ready for sale to the customer.
• Finished goods costs: Consists of completed units of
product that have not yet been sold to customers.

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Transfer of Product Costs
• When direct materials are used in production, their costs
are transferred from Raw Materials to Work in Process.
• Direct labor and manufacturing overhead costs are added
to Work in Process to convert direct materials into
finished goods.
• Once units of product are completed, their costs are
transferred from Work in Process to Finished Goods.
• When a manufacturer sells its finished goods to
customers, the costs are transferred from Finished Goods
to Cost of Goods Sold.

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Cost Classifications for Preparing
Financial Statements
Product costs include
direct materials, direct
labor, and manufacturing
overhead.
Period costs include all
selling costs and
administrative costs.
Access the text alternative for slide images.

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Quick Check 1
Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Sales commissions.

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Quick Check 1a
Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Answer: Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Answer: Sales commissions.

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Learning Objective 4
Understand cost classifications used to
predict cost behavior: variable costs, fixed
costs, and mixed costs.

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Cost Classifications for Predicting Cost
Behavior
Cost behavior refers to how a cost will react to
changes in the level of activity.
The most common classifications are:
• Variable costs.
• Fixed costs.
• Mixed costs.

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Variable Cost
A cost that varies, in total, in direct proportion to
changes in the level of activity.
A variable cost per unit is constant.

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An Activity Base (Cost Driver)
A measure of what causes the incurrence of a
variable cost:
• Units produced
• Machine hours
• Miles driven
• Labor hours

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Fixed Cost
A cost that remains constant, in total, regardless of
changes in the level of the activity.
If expressed on a per-unit basis, the average fixed
cost per unit varies inversely with changes in
activity.

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Types of Fixed Costs
Committed
Long-term, cannot be
significantly reduced
in the short term
Discretionary
May be altered in the
short term by current
managerial decisions

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The Linearity Assumption and the
Relevant Range
A straight line closely approximates a curvilinear variable
cost line within the relevant range.
Access the text alternative for slide images.

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Fixed Costs and the Relevant Range
The relevant range of activity pertains to the fixed
cost as well as variable costs. For example, assume
office space is available at a rental rate of $30,000
per year in increments of 1,000 square feet.
Fixed costs would increase in a step fashion at a
rate of $30,000 for each additional 1,000 square
feet.

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Relevant Range: Graphic
The relevant range of activity for a fixed cost is the
range of activity over which the graph of the cost is flat.
Access the text alternative for slide images.

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Comparison of Cost Classifications for
Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost increases and
decreases in proportion to
changes in the activity level.
Variable cost per unit remains
constant.
Fixed Total fixed cost is not affected
by changes in the activity level
within the relevant range.
Fixed cost per unit decreases as
the activity level rises and
increases as the activity level
falls.

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Quick Check 2
Which of the following costs would be variable with respect
to the number of ice cream cones sold at Baskin-Robbins?
(There may be more than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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Quick Check 2a
Which of the following costs would be variable with respect
to the number of ice cream cones sold at Baskin-Robbins?
(There may be more than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. Answer: The cost of ice cream.
D. Answer: The cost of napkins for customers.

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Mixed Costs 1
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.
Access the text alternative for slide images.

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Mixed Costs 2
The total mixed cost line can be expressed as an equation: Y = a + bX
Where:
Y = Total mixed cost
a = Total fixed cost (the vertical intercept of the line)
b = Variable cost per unit of activity (the slope of the line)
X = Level of activity

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Mixed Costs – An Example
If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what
is the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100

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Learning Objective 5
Understand cost classifications used in
making decisions: relevant costs and
irrelevant costs.

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Cost Classifications for Decision Making
Decisions involve choosing between alternatives. The goal of
making decisions is to identify those costs that are either
relevant or irrelevant to the decision.
To make decisions, it is essential to have a grasp on the
concepts of differential costs and revenues, opportunity
costs, and sunk costs.

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Differential Costs
Differential costs (or incremental costs) are
the difference in cost between any two
alternatives.
A difference in revenue between two
alternatives is called differential revenue.
Both are always relevant to decisions.
Differential costs can be either fixed or
variable.

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Opportunity Cost
The potential benefit that is given up when one
alternative is selected over another.
These costs are not usually found in accounting
records but must be explicitly considered in every
decision.
For students: What opportunity cost do you incur
by attending class?

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Sunk Costs
Sunk costs have already been incurred and cannot
be changed now or in the future.
These irrelevant costs should be ignored when
making decisions.

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Quick Check 3
Suppose you are trying to decide whether to drive or take
the train to Portland to attend a concert. You have ample
cash to do either, but you don’t want to waste money
needlessly. Is the cost of the train ticket relevant in this
decision? In other words, should the cost of the train ticket
affect the decision of whether you drive or take the train to
Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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Quick Check 3a
Suppose you are trying to decide whether to drive or take
the train to Portland to attend a concert. You have ample
cash to do either, but you don’t want to waste money
needlessly. Is the cost of the train ticket relevant in this
decision? In other words, should the cost of the train ticket
affect the decision of whether you drive or take the train to
Portland?
A. Answer: Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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Quick Check 4
Suppose you are trying to decide whether to drive or take
the train to Portland to attend a concert. You have ample
cash to do either, but you don’t want to waste money
needlessly. Is the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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Quick Check 4a
Suppose you are trying to decide whether to drive or take
the train to Portland to attend a concert. You have ample
cash to do either, but you don’t want to waste money
needlessly. Is the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. Answer: No, the licensing cost is not relevant.

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Quick Check 5
Suppose that your car could be sold now for $5,000. Is this a
sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

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Quick Check 5a
Suppose that your car could be sold now for $5,000. Is this a
sunk cost?
A. Yes, it is a sunk cost.
B. Answer: No, it is not a sunk cost.

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Learning Objective 6
Prepare income statements for a
merchandising company using the
traditional and contribution formats.

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The Traditional and Contribution Formats
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Uses of the Contribution Format
The contribution income statement format is used as an
internal planning and decision-making tool. We will use
this approach for:
1. Cost-volume-profit analysis (Chapter 5).
2. Segmented reporting of profit data (Chapter 6).
3. Budgeting (Chapter 8).
4. Special decisions such as pricing and make-or-buy
analysis (Chapter 13).

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End of Chapter 1